Qualifying Plans Down on the Hacienda (Puerto Rico)

Sponsors of tax-qualified retirement plans that have employees resident in Puerto Rico or employees that received Puerto Rico source contributions should be aware that Puerto Rico has its own system for qualifying retirement plans. While the provisions in Puerto Rico's tax code relating to qualified plans are similar to those in the Internal Revenue Code, there are a number of important distinctions. Typically, if the sponsor of a retirement plan qualified in the United States wishes to have its plan qualified in Puerto Rico, an addendum to the plan needs to be prepared that outlines the different rules that will apply to Puerto Rican participants. An alternative approach to compliance is to have the plan sponsor adopt a separate plan covering its Puerto Rican employees. A determination request must be filed with the Hacienda, Puerto Rico's Department of Treasury, which, like the IRS, will work with the plan sponsor to issue a favorable determination on the qualified status of the plan if the addendum is prepared in a manner satisfactory to the Hacienda. Unlike the federal income tax rules, however, a retirement plan cannot be a qualified plan unless it is filed with and receives the approval of the Hacienda.

Under Puerto Rico's tax code, one lone Puerto Rican participant (either a Puerto Rican resident who accrues benefits or gets a distribution under the plan or a U.S. resident who accrued benefits under the plan based on compensation earned in Puerto Rico) is enough to trigger the requirement to have the plan become Puerto Rico-compliant. Puerto Rican authorities have adopted a program to assist employers who were not aware of the separate qualification requirement under Puerto Rican law: If an employer's U.S. tax qualified retirement plan is amended by December 31, 2012, to include the provisions applicable to Puerto Rican participants, and if a determination request with respect to the plan is filed with the Hacienda by April 15, 2013, (or any later extended return filing due date), the Hacienda will not pursue the employer for failing to comply with Puerto Rican law prior to 2013. While a further extension of these due dates was recently announced, we are not certain that relying on the extension will provide the same level of protection for prior years. Accordingly, we recommend that employers that have decided to amend their plans to comply with Puerto Rico laws adhere to the original December 31, 2012, and April 15, 2013, deadlines.

If a plan that has Puerto Rican participants is not qualified under Puerto Rican law, it is treated as a nonqualified plan of deferred compensation for Puerto Rican participants. This means that Puerto Rican participants would be taxed when contributions to the plan made on their behalf are no longer subject to a substantial risk of forfeiture. It also means that earnings on vested accounts would be taxable to Puerto Rican participants. Finally, it means that the plan sponsor making the contributions will not be able to deduct the contributions until they are treated as income to the Puerto Rican participant. Since in most cases it will be fairly easy to create a plan addendum and to file a determination request with the Hacienda, we recommend that any employer that has Puerto Rican plan participants take the steps necessary to qualify the plan under Puerto Rican law. Life in the Hacienda is changing – affected employers need to adapt.